We suggest a new approach for analyzing the role of financial variables and shocks in
computing the output gap. We estimate a two-region DSGE model for the euro area, with
financial frictions at the household level, between 2000-2013. After joining the monetary
union, a decline in some countries' borrowing costs contributed to a credit, housing and real
boom and bust cycle. We show that financial frictions amplified economic fluctuations and
the measure of the output gap in those countries. On the contrary, in countries such as France
and Germany, financial frictions played a minor role in output gap measures. We also present
evidence of the trade-offs faced by the European Central Bank when trying to stabilize two
regions in a currency union with unsynchronized economic cycles.